Windfall Tax Why in News: The Central government introdu | UPSC Mains 2023 Materials
Windfall Tax
Why in News: The Central government introduced a windfall profit tax of ₹23,250 per tonne on domestic crude oil production, which has fluctuating rates.
FM defended the windfall tax saying that it was done after full consultation with the industry and explained the introduction of the windfall tax as a way to rein in the “phenomenal profits” made by some oil refiners who chose to export fuel to reap the benefits of skyrocketing global prices while affecting domestic supplies
Windfall Tax:
The U.S. Congressional Research Service (CRS) defines a windfall as an “unearned, unanticipated gain in income
through no additional effort or expense”.
They are called so as the profits are derived from an external or unprecedented event or from something the firm actively did not participate in for instance.
Typically, it’s levied as a one-off tax retrospectively over and above the normal rates of tax.
In oil markets, price fluctuation leads to volatile or erratic profits for the industry. Hence, tax is levied to redistribute unexpected gains when high prices benefit producers at the expense of consumers.
It can be used to fund social welfare schemes
Need for Windfall Tax
To narrow the country’s widened trade deficit on account of rising prices of oil, gas, & coal
Rise in prices due to pandemic recovery & supply issues resulting from the Russia-Ukraine conflict & consequent increase in energy demands.
The rising prices imply huge profits for energy companies while resulting in hefty gas & electricity bills for households widening income inequality.
The “grotesque greed” of big oil and gas companies eg. the largest energy companies in the first quarter of the year made combined profits of close to $100 billion.
Challenges
Adverse impact on investments: Introducing a temporary windfall profit tax reduces future investment because prospective investors will internalise the likelihood of potential taxes when making investment decisions and avoid uncertainty on account of retrospective nature of tax and influence of unexpected events and surprises.
Such taxes are populist & politically opportune in the short term.
The IMF said taxes in response to price surges may suffer from design problems—given their expedient & political nature.
Difficulty in constituting true windfall profits; their determination and level of normalisation of profit. A CRS report, for instance, argues that if rapid increases in prices lead to higher profits, in one sense it can be called true windfalls
as they are unforeseeable but on the other hand, companies may argue that it is the profit they earned as a reward for risk-taking to provide the end user with the petroleum product.
Issue of determining who should be taxed only the big companies responsible for the bulk of high-priced sales or
smaller companies as well or whether producers with revenues or profits below a certain threshold should be exempt IMF Guidelines on the matter
Introduce a permanent tax on windfall profits from fossil fuel extraction.
Use caution in temporary taxes on windfall profits because these tend to increase investor risk, may be more distortionary (especially if poorly designed or timed), and do not provide revenue benefits above those of a permanent
tax on economic rents.
The tax should be imposed on a share of economic rents (meaning excess profits).
Economic rents generally arise from fossil fuel extraction as a result of the fixed supply and diverse. Rent-targeting taxes raise revenue without reducing investment or increasing inflation.
Encourage the switch to renewable energy, given the need for decarbonization in energy generation. Transitioning to renewable energy improves energy security.
Design principles: Tax should apply to a clear measure of excess profit; tax should not apply to revenue as this can
be inflationary and reduce investment. The tax should allow for carry forward of losses to ensure symmetrical
treatment.
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